Effects of the Subprime Crisis in

Emerging Markets

Britt Gwinner, CFA

Principal Financial Specialist

International Finance Corporation

Fortaleza, 17 March, 2010

1

2

IFC and Housing

• Construction finance

Brazil – Cyrela, Brookfield

Mexico – Vinte

• Primary mortgage lenders

Mexico, Colombia, India, Russia

• Housing Microfinance

Peru, Afghanistan, Pakistan

• Secondary mortgage markets

Brazil (Cibresec), Colombia, Mexico, India, Russia

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Contents

1. The Basic Picture – Housing Finance in Emerging Markets

2. What Happened in Developed Markets?

3. What Happened in Emerging Markets?

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THE BASIC PICTURE

Section 1

4

5

The crisis did not change the basic picture

• Developed countries resolved housing shortages in the 1950s

and 1960s

Less than 1% of housing units in the wealthy countries of Asia, Europe, or

North America suffer from inadequate conditions

Solutions came from financing schemes, urban planning, and subsidies (of

varying efficiency and efficacy)

• Housing deficits persist in Latin America, Asia, Africa

Self-built houses on squatted land often lack connections to sewage or water, built of inadequate materials, structures inadequate to withstand earthquakes, hurricanes

In Africa, close to half of all households, 44.7%, lack access to improved

sanitation; in South Asia, about a quarter lack sanitation, 25.6%

In Latin America between 20 and 30 million housing units are lacking in

some fundamental aspect, such as running water, sanitation, constructed

from inadequate materials, etc.

Inadequate housing compounds the cycle of poverty – health, social investment, wealth-building

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66

• For past 40 years, in emerging markets, formal sector housing

production has rarely matched the rate of household

formation

In Mexico, production approximated demand for the first time in 2006 (600k mortgages issued), then fell short in 2009 as construction finance slowed

• Rising incomes in past eight years permit more households to

afford mortgages

Real disposable personal income rose ’00-’08 an average 3% per year in Peru, 2.4% in Colombia, 1.6% in Brazil

But incomes fell slightly over same period in Mexico, Argentina

• Lack of long-term funding - most emerging capital markets fail to extend beyond one year maturities with any depth or liquidity

Housing shortages, rising incomes, limited financing

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Mortgages mostly unavailable in emerging markets

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0%

20%

40%

60%

80%

100%

Den

mark

Un

ited

Sta

tes

Sp

ain

Germ

an

y

Jap

an

Mala

ysia

Ko

rea

Pan

am

a

Italy

Th

ailand

Mo

rocco

Ch

ile

Ch

ina

Lith

uan

ia

Mexic

o

Po

lan

d

Co

lom

bia

Turk

ey

country

Mortgage Debt as Percent of GDP Selected Countries

Developed

countries 40-100%

Emerging markets< 20%

Source: World Bank

WHAT HAPPENED IN

DEVELOPED MARKETS?

Section 2

8

U.S. subprime boom and bust – excessive

leverage, weak credit underwriting

9

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

50

70

90

110

130

150

170

190

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Do

llars

in

Mil

lio

ns

S&

P/C

ase-S

hil

ler

Nati

on

al

Ho

use P

rice I

nd

ex

Year

U.S. House Prices and Mortgage Originations

House Prices

Total Mortgage Originations(Right Hand Scale)

Subprime

FHA/VA

Sources: S&P Case-Shiller, Inside Mortgage Finance

10

European credit bubbles broke – weak

underwriting, excessive leverage

• Credit bubbles in Portugal, Ireland, Italy, Spain, Greece

included housing finance and other asset classes

• German public banks with offshore highly leveraged investment

funds

• Fitch 2009: rising unemployment and falling house prices lead

to “…asset performance deterioration expected to continue

across the UK and the Euro area...”

• Fitch on German non-conforming mortgages 2009: “High early

stage delinquencies and low recoveries have already led to

negative rating actions, more likely to follow.”

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European & U.S. crisis response

• Central banks’ quantitative easing, low interest rates

95% of all securitization issuance in Europe for 2008 was retained for repo

purposes, notably with the ECB and the BoE;

Federal Reserve term liquidity facilities provided USD 1.5 trillion at their

peak, pricing incentivized exit, down to USD 20 billion March, 2010

• Deep haircuts - financial institutions pledged £287 billion face

value in securities to the Bank of England’s Special Liquidity

Scheme in order to borrow £185 billion in funding

• Lending falls – Private sector lending in Europe fell €47 billion

in December from November 2008 as credit standards tightened

and unemployment rose. Lending to households fell by €20

billion in December, for a total drop of €37 billion in Q408.

• Rescue efforts: e.g., Bank of England’s Homeowner Mortgage

Support Scheme, Spain’s Financial Asset Acquisition Fund

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12

Risk prices rise and investors differentiate

12

Spread on

Spanish issues

rises to 680bp

Netherlands

suffers least

Source: AFME

01/07, every

AAA issue is

about 20bp

0

50

100

150

200

250

300

350

2007:Q1 2007:Q2 2007:Q3 2007:Q4 2008:Q1 2008:Q2 2008:Q3 2008:Q4 2009:Q1 2009:Q2 2009:Q3

USD

bill

ion

s

U.S. Structured Finance Issues 1Q07-3Q09

ABS CDO Agency MBS Non-Agency RMBS

Government -backed RMBS

ABS - credit cards, autos, short term

Private-IssueRMBS

13

U.S. structured finance goes public (sector)

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Source: AFME

In 2008 & 2009, the

Fed bought most

new issuances by

Fannie and Freddie

WHAT HAPPENED IN EMERGING

MARKETS?

Section 3

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15

What have actual defaults looked like?

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0%

5%

10%

15%

20%

25%

30%

35%

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A largely external crisis

• There are no subprime mortgages in emerging markets

But some signs of loosened underwriting in Mexico, some others in 2007, 2008

• Emerging sovereigns benefitted from low borrowing spreads during

the boom

But, macro management has broadly been strong, emerging markets come out of

the crisis with relatively low decline in GDP, many cases of growth

• At the worst of the crisis, funding retreated to New York, London,

Madrid, etc.

• Limited development of some capital markets mitigated bad effects –

e.g., Egypt, Guatemala

• Relatively strong economic performance protected others – China,

Brazil, Peru

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LAC RMBS during the crisisReliance on local investors, mostly low mortgage delinquencies,

persistent demand from private pensions and insurers

• Colombia – Structured finance issuances 2009 almost twice 2008, TC

placed USDeq 791 million in RMBS 2009, mortgage delinquencies 4.5%

2009, expected stable 2010, more than half of recent issues

purchased by domestic pension funds

• Chile – Structured issuances up 6 times in 2009 v. 2008, of this, 9%

was RMBS

• Panama – La Hipotecaria securitized consumer loans 9/08, rolls

commercial paper through end 2009, issues MTNs 04/09 – all to local

investors

• Peru – corporate issuances continue, structured finance for auto,

consumer, leasing, and Titulizadora Peruana issues RMBS 02/10

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Outlook for Mexican Mortgages and RMBS

• 2008 – Flight from mortgages by local and international investors

• 2009 – Return of bank issuance (BBVA Bancomer), also Infonavit,

Fovissste

• Sofols/Sofoms remain sector non grata

Metrofinanciera cash diversion; Crédito y Casa collections problems

Cessation of long- and short-term wholesale funding to sofols/sofoms

Rising delinquencies from U.S. crisis, swine flu, local unemployment

Return of SHF funding, limits to SHF balance sheet

Government push to get banking licenses and recapitalize

• Rescue of sofols/sofoms by bond investors is unlikely until their

charters change or they are recapitalized

• Housing demand is strong, inflation is low, house prices are stable

Banks and state institutions are actively lending

Construction finance is restricted – project pipeline fell 40% 2009

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NBFIs in emerging markets

Non-bank financial institutions have led innovation for the

underserved in emerging markets

Housing, microfinance, and leasing in Mexico, Colombia, Peru, India, etc.

Lower entry costs, less stringent regulations, lower minimum capital,

lower overhead compared to banks

Mortgage NBFIs face specific funding issues because of longer

maturities

Mortgage banks have thrived in the U.S. via securitization by

government-sponsored entities

In Mexico, SHF is supporting Sofoles through the crisis, but eventual

transition to banks is expected

In Chile, administradores hipotecarias have succeeded with contracts to

insurers

The crisis highlights the importance of local institutional investors

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Going forward

• Demand for housing by moderate and lower income households

persists

• Rising incomes create increased capacity to pay for mortgages

• Growing institutional investors want long term paper

• Many of the obstacles to development of capital markets for

mortgages are long-standing but can be overcome

• The hardest problem for long-maturity finance is inflation

• Lessons learned from NBFI problems and investor flight in Mexico –

grow lending carefully, focus on educating and developing the local

investor base, add international sales as a supplement

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THANK YOU!

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